“David wants to take six billion out of the economy when it is most at risk” said Gordon Brown, more times than I care to remember in each of the television debates. This statement hints at an economic misunderstanding that is almost as old as the subject itself, and is worryingly ubiquitous in the post-crisis discourse.
The fallacy was first laid out and refuted by Frederic Bastiat in 1850 in the form of the ‘broken window fallacy’. Bastiat’s example goes as follows: while at a first glance it may seem that the breaking of a bakery’s window in town somewhere creates employment for the glazier and must therefore be a good thing for the town, this doesn’t take into account the “unseen” consequences of the act. The baker has to pay the glazier; while the glazier benefits from this, it means that the baker is not able to buy that new suit he really wanted. So, stay with me on this, if the window had never been broken, the baker would have a new suit and the tailor would have been paid for the suit – the wants of two people have been fulfilled. But with the window broken, the only person who benefits is the glazier.
Now, this is not a mere argument against vandalism, but a profound allegory at the heart of which is a truth that is missed by many commentators and economists.
So, what of the six billion? Lets go with Brown for now on the point that this money is ‘stimulus money’, which is a dubious assumption given that much of it is probably waste. This money, like the money used to pay the glazier, has to come from somewhere, the government has to raise it via taxation or bond issuing. When the government ‘puts money into the economy’ it is really just moving it from one area (the pocket of individuals or the portfolio of the bond investors) to another*. The money has to be removed from the economy before it can be ‘put back in’.
The argument, made by economist and ex-MPC member David Blanchflower, that ‘this was a public-sector sustained recovery’, just doesn’t make much sense, especially as a justification for keeping an extra six billion in the economy. The public sector gets its money from the private sector, so the money is in reality just being retargeted by the government into whatever the £6bn is being spent on.
Brown is right to say that he is keeping the money in the economy, but wrong to assert that cutting this money would be taking it out of the economy. In fact, it would be giving the money back to the economy, but in a different place (hopefully the pockets of taxpayers). If this all sounds a bit confusing, I would recommend Henry Hazlitt’s Economics in One Lesson, a short, easy book expounding the ideas of Bastiat and available free to read online.
*That is assuming that it isn’t just printing all the money, which introduces the idea of inflation and a whole different can of worms.